Ratings are assigned on the basis of extensive economic analysis by the rating agencies mainly to determine revenues available to the issuer to cover debt service. The more money available to cover the debt service, the higher the rating.
When forecasting economic conditions for the next six months or for perhaps one year, experts stand on reasonably secure ground. But the further they predict into the future, the more imprecise and unreliable their forecasts become. Any prediction of economic conditions that goes out more than five years becomes guesswork. Bear in mind, however, that bonds are rated for their entire life, even if that is 30 years.
As a result, some forecasts turn out to be incorrect. When ratings are reviewed, they may change. As the economic fortunes of the issuer vary, so will the ratings.
Over time, changes in ratings can be major. For example, State of Louisiana bonds were rated AAA in the mid-1980s. In early 1990, they were rated barely investment grade. Occasionally, changes in ratings are more sudden. For instance, State of Massachusetts ratings went from AA to barely investment grade within the space of one year.
More dramatic rating changes sometimes occur in the corporate bond sector. For example, if a company buys another with debt, the amount of debt may increase sharply virtually overnight. And that increase would cause the rating to deteriorate virtually overnight as well.
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